Resource Investors to Watch Mongolian Parliamentary Elections

Vancouver-based Ivanhoe Mines (NYSE:IVN), now majority owned by Rio Tin to (NY S E:RIO), recently announced that initial production will commence during the third quarter of this year at its Oyu Tolgoi or "Turquoise Hill" copper-gold mine in Southern Mongolia's Gobi desert.

Mongolia's impressive store of natural resources and close proximity to the world's most resource-ravenous nation - China - have made it a hotbed for exploration in recent years.

"Four-fifths of the country is still unsurveyed," writes Dexter Roberts, Asia News Editor at Bloomberg Businessweek. "Over the next decade copper production is expected to double, iron ore to triple, coal to grow by six times, and gold and oil by 10 and 13 times, respectively."

In the face of worldwide recession, and with many of the world's leading economies struggling to post gains, the Central Asian nation's GDP grew 17.3 percent in 2011 thanks to its burgeoning resource industry. The International Monetary Fund projects an average growth of 14 percent over the next four years.

The Oyu Tolgoi mine is one of the world's largest copper-gold deposits, and over the next 50 years it is expected to produce more than 81 billion pounds of copper and 46 million ounces of gold; the impressive project's forecasted annual copper production of 450,000 tonnes per year will position Rio Tinto as one of the world's top three copper producers. The Mongolian government has a 34 percent share in the project, which is expected to account for a third of Mongolia's GDP by 2020.

Ivanhoe Mines founder and CEO Robert Friedland anticipates the mine will reach full commercial production in the first half of 2013.

Resource nationalism influences Mongolian politics

However, opportunities like Oyu Tolgoi are not without risks. Mongolia has proven susceptible to a growing trend in mineral-rich developing nations: resource nationalism. A recent Ernst & Young Mining and Metals Survey of the world's 30 largest miners identified resource nationalism as the biggest risk factor for mining companies in 2011-12. In 2011, more than two dozen nations sought to increase their portion of mining profits, and others announced intentions to fully nationalize their resources.

Ivanhoe's announcement follows many years of struggles with the Mongolian government, which has been intent on securing a large piece of the profit pie for its foreign business-leery populace. Ivanhoe first drilled the massive Oyu Tolgoi deposit in 2000, and began negotiations with the government over developing the project in 2003.

In 2006, the government enacted a 68 percent windfall profits tax on copper sold above $2,600/ton and gold above $850 an ounce, as well as a mandate of a 34 percent government stake in mining projects. These changes were a stark indication that the government of Mongolia was under extreme pressure from political groups pushing for nationalization of the country's natural resources. The negotiations over control became so heated that protesters were burning effigies of Friedland.

The heavy windfall tax, the largest in the world, was later revoked in late 2009.

There were concerns that Oyu Tolgoi would fall victim to the same fate as Tavan Tolgoi, which the Mongolian government, bowing to populist political pressure, took control of in 2008. The multi-billion dollar coal mine had been owned by Energy Resources, a private Mongolian company funded by foreign dollars.

The project is now operated by a state-owned resource company that plans to launch a $3 billion IPO with listings on Ulan Bator, the LSE, and the Hong Kong exchange; each Mongolian citizen will become a shareholder for a total of ten percent of entire shares.

Immense poverty behind push for resource nationalization

Mongolia's rising GDP hasn't helped to reduce the nation's poverty rate, which has been climbing in recent years, reaching 40 percent in 2011. The sting of poverty is made all the worse for Mongolians when they see foreigners profiting from their country's natural resources.

Public anger at foreign miners and mining-friendly politicians has risen along with the poverty rate. Some are pushing the government to take a larger position in mining projects, while others are calling for the outright nationalization of resources, banning foreign companies from operating in Mongolia altogether. Protestors have gone as far as shooting arrows at the Government House on horseback and firing bullets at mining equipment owned by Canadian and Chinese companies.

Answering public demands, the Mongolian government created a "human development fund" with money garnered from prepaid taxes from foreign investors in the Oyu Tolgoi mine; each Mongolian receives the equivalent of $17 from the fund each month.

Investors to watch upcoming parliamentary elections

In its 22-year history as a democracy, the Mongolian government's policies have leaned toward populist sentiment. "Since leaving the Soviet Union, Mongolia has zigzagged between privatization and nationalization," said Bloomberg's Roberts. Roberts points out it's this tendency to appease populist calls to nationalize industry that led to the passage of the 2006 windfall profits tax on gold and copper.

While ensuring that citizens benefit from the bonanza of natural resources within the nation's borders and protecting the environment are without question the duty of any government, enacting mining policies that only serve to drive away foreign investment, technology, and know-how is short-sighted.

"Mongolian governments adopted a harder bargaining stance to protect national interests, but in doing so they discouraged foreign investors," points out Dr. Richard Pomfret, Professor of Economics at the University of Adelaide, in an extensive paper on exploiting resources in Central Asia. The government's negotiating position with Ivanhoe delayed production for over a decade, and "[i]n consequence, Mongolia failed to benefit from the copper price boom of the 2000s."

As the June parliamentary elections near, the rights to Mongolia's vast store of natural resources is becoming an even greater political issue. "While issues such as family, clan and religion are still important, the mining boom, business and nationalism have taken on a much greater significance in people's voting intentions," says Oliver Belfitt-Nash, Mongolia-based reporter for Business New Europe.

Uncertainty concerning just how far politicians are willing to move toward resource nationalism in an effort to win votes is understandably raising Mongolia's political risk factor in the eyes of resource investors.

Is the Mongolian government looking at other projects it can use to increase its share of the profits? The answer will become more apparent as June draws near.

Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.